Meadowbrook Insurance (MIG) 10-Q 2000 Q1 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549

FORM 10-Q

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarter ended March 31, 2000
or
[   ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-14094

Meadowbrook Insurance Group, Inc.
(Exact name of registrant as specified in its charter)

Michigan	38-2626206
(State of Incorporation)	(IRS Employer Identification No.)

26600 Telegraph Road, Southfield, Michigan 48034
(Address, zip code of principal executive offices)

(248) 358-1100
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes __X__ No _____

The aggregate number of shares of the Registrant’s Common Stock, $.01 par value, outstanding on May 11, 2000 was 8,511,655.

1

TABLE OF CONTENTS

FORM 10-Q
PART 1 — FINANCIAL INFORMATION ITEM 1 FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENT OF INCOME
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
CONDENSED CONSOLIDATED BALANCE SHEET
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MANAGEMENT REPRESENTATION
ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
PART II -OTHER INFORMATION
	ITEM 1. LEGAL PROCEEDINGS
	ITEM 6. EXHIBITS AND REPORTS ON FORM 8K
SIGNATURES

TABLE OF CONTENTS

		PAGE
PART I — FINANCIAL INFORMATION
ITEM 1 — FINANCIAL STATEMENTS
	Condensed Consolidated Statement of Income	3
	Consolidated Statement of Comprehensive Income	4
	Condensed Consolidated Balance Sheet	5
	Condensed Consolidated Statement of Cash Flows	6
	Notes to Consolidated Financial Statements and Management Representation	7-10
ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS           OF FINANCIAL CONDITION AND RESULTS OF           OPERATIONS		11-13
PART II — OTHER INFORMATION
ITEM 1 — LEGAL PROCEEDINGS		14
ITEM 6 — EXHIBITS AND REPORTS ON FORM 8-K		14
SIGNATURES		15

2

PART 1 — FINANCIAL INFORMATION
ITEM 1
FINANCIAL STATEMENTS

MEADOWBROOK INSURANCE GROUP, INC.

CONDENSED CONSOLIDATED STATEMENT OF INCOME

For the Quarters Ended March 31,
(Unaudited)
(in thousands)

			2000			1999
Revenues:
	Net premium earned		$	33,268		$	26,159
	Net commissions and fees			10,182			9,048
	Net investment income			2,787			2,709
		Total Revenues		46,237			37,916
Expenses:
	Loss and loss adjustment expenses			53,472			42,691
	Reinsurance recoveries			(30,170	)		(21,900	)
	Net loss and loss adjustment expenses			23,302			20,791
	Other operating expenses			10,629			8,822
	Salaries and employee benefits			10,725			9,911
	Interest on notes payable			1,240			840
	Amortization of intangible assets			480			345
		Total Expenses		46,376			40,709
		Loss before income taxes		(139	)		(2,793	)
Federal income tax benefit				(244	)		(1,355	)
	Net income (loss) before cumulative effect of accounting change			105			(1,438	)
	Cumulative effect of accounting for insurance related assessments, net of deferred taxes of $879			—			(1,706	)
	Net Income (Loss)		$	105		$	(3,144	)

The accompanying notes are an integral part of the consolidated financial statements.

3

MEADOWBROOK INSURANCE GROUP, INC.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

For the Quarters Ended March 31,
(Unaudited)
(in thousands)

				2000
Net income				$	105
	Other comprehensive loss, net of tax:
		Unrealized losses on securities:
			Unrealized holding losses arising during the period		(417	)
			Less: reclassification adjustment for losses included in net income		11
Other comprehensive loss					(406	)
Comprehensive loss				$	(301	)

				1999
Net loss				$	(3,144	)
	Other comprehensive loss, net of tax:
		Unrealized losses on securities:
			Unrealized holding losses arising during the period		(1,161	)
			Less: reclassification adjustment for gains included in net loss		(19	)
Other comprehensive loss					(1,180	)
Comprehensive loss				$	(4,324	)

The accompanying notes are an integral part of the consolidated financial statements.

4

MEADOWBROOK INSURANCE GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEET

ASSETS
(in thousands)

				(Unaudited)
				March 31,			December 31,
				2000			1999
Investments:
	Debt securities available for sale, at fair value       (cost of $192,092 and $188,755)			$	188,856		$	185,241
	Equity securities available for sale, at fair value       (cost of $17,080 and $17,087)				15,656			16,569
Cash and cash equivalents					25,551			23,713
		Total investments and cash and cash equivalents			230,063			225,523
Premiums and agent balances receivable					79,124			85,707
Reinsurance recoverable on:
	Paid losses				15,956			14,051
	Unpaid losses				113,211			101,744
Deferred policy acquisition costs					12,223			10,030
Prepaid reinsurance premiums					43,886			42,073
Intangible assets					32,382			33,859
Other assets					42,103			38,990
	Total assets			$	568,948		$	551,977
			LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Reserve for losses and loss adjustment expenses				$	244,915		$	229,244
Unearned premiums					98,035			90,095
Notes payable, bank					58,649			58,463
Other liabilities					67,502			73,767
	Total liabilities				469,101			451,569
Contingencies and commitments
Shareholders’ Equity:
Common stock, $.01 par value; authorized 20,000,000 shares:
	8,511,655 shares issued and outstanding				85			85
Additional paid-in capital					67,912			67,907
Retained earnings					35,660			35,809
Note receivable from officer					(720	)		(720	)
Accumulated other comprehensive income					(3,090	)		(2,673	)
	Total shareholders’ equity				99,847			100,408
		Total liabilities and shareholders’ equity		$	568,948		$	551,977

The accompanying notes are an integral part of the consolidated financial statements.

5

MEADOWBROOK INSURANCE GROUP, INC.

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

For the Three Months Ended March 31,
(Unaudited)
(in thousands)

			2000			1999
Net cash provided by operating activities			$	7,069		$	12,584
Cash flows (used in) provided by investing activities:
	Purchase of debt securities available for sale			(8,151	)		(29,260	)
	Purchase of equity securities available for sale			(149	)		(9,195	)
	Proceeds from sale of debt securities available for sale			4,738			26,077
	Proceeds from sale of equity securities available for sale			148			107
	Other investing activities			(1,154	)		(916	)
		Net cash used in investing activities		(4,568	)		(13,187	)
Cash flows (used in) provided by financing activities:
	Net (payments) proceeds of bank loan			185			(2,594	)
	Dividends paid on common stock			(255	)		(260	)
	Other financing activities			(593	)		(6	)
		Net cash used in financing activities		(663	)		(2,860	)
Increase (decrease) in cash and cash equivalents				1,838			(3,463	)
Cash and cash equivalents, beginning of period				23,713			20,510
Cash and cash equivalents, end of period			$	25,551		$	17,047

The accompanying notes are an integral part of the consolidated financial statements.

6

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 — Earnings Per Share (EPS)

	For the Three Months Ended March 31,
	(Unaudited)
	2000		1999
Basic EPS
Net income (loss) before cumulative    effect of accounting change	$	0.01	$	(0.16	)
Cumulative effect of accounting change			$	(0.20	)
Net income (loss)	$	0.01	$	(0.36	)
Diluted EPS
Net income (loss) before cumulative effect of accounting change	$	0.01	$	(0.16	)
Cumulative effect of accounting change			$	(0.20	)
Net income (loss)	$	0.01	$	(0.36	)
Weighted average of number of    common shares outstanding:
Basic		8,511,655		8,663,434
Diluted		8,522,313		8,831,696

NOTE 2 — Commitments & Contingencies

On June 26, 1995, two shareholders and an officer of a former agent (the “Primary Plaintiffs”) of Star Insurance Company (“Star”), and a former spouse of one shareholder and an employee of the former agent (the “Individual Plaintiffs”) initiated legal proceedings against, among others, Star and Meadowbrook, Inc. (“Meadowbrook”) in the District Court for Washoe County, Reno, Nevada. All of the plaintiffs requested injunctive relief, compensatory damages, punitive and exemplary damages, and attorney’s fees in an unspecified amount. The Nevada Insurance Department revoked the license of one of the Primary Plaintiffs and one of the Individual Plaintiffs and denied further licensing of the other Primary Plaintiffs.

7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — continued

Meadowbrook and Star vigorously defended themselves and filed counterclaims against the Primary and Individual Plaintiffs. On April 1, 1998, the Court issued an Order dismissing all claims of the Primary Plaintiffs with prejudice.

On January 12, 1999, the remaining claims of the Individual Plaintiffs and the counterclaims of Meadowbrook and Star against the Primary and Individual Plaintiffs were tried. On February 2, 1999, the jury returned a verdict in favor of Meadowbrook and Star against the Primary Plaintiffs and Individual Plaintiffs. In addition, the jury found against the Individual Plaintiffs and in favor of Meadowbrook and Star on their remaining claims. On April 21, 1999, the Court found in favor of Meadowbrook and Star and against the Primary and Individual Plaintiffs on all outstanding claims for equitable relief. It is not expected that the outcome of this litigation will have a material impact on the financial condition of the Company.

A Final Judgment has been entered with the Court, which is subject to an appeal.

NOTE 3 — Cumulative Effect of Accounting Change

As described in our 1998 Annual Report, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 97-3, “Accounting by Insurance and Other Enterprises for Insurance-Related Assessments” (“SOP 97-3”). SOP 97-3 provides guidance for determining when an entity should recognize a liability for guaranty-fund and other insurance-related assessments, how to measure that liability, and when an asset may be recognized for the recovery of such assessments through premium tax offsets or policy surcharges. As required, the Company adopted SOP 97-3 in the quarter ended March 31, 1999. The adoption of SOP 97-3 resulted in a non-cash after-tax $1.7 million (net of tax of $879,064), or $0.20 per share, cumulative effect accounting change.

NOTE 4 — Reclassifications

Certain amounts in the 1999 notes to consolidated financial statements have been reclassified to conform with the 2000 presentation.

NOTE 5 — Segment Information

Agency Operations

The agency segment was formed in 1955 as Meadowbrook’s original business. The insurance agency places principally commercial insurance, as well as personal property, casualty, life and accident and health insurance, with more than 50 insurance carriers from which it earns commission income. The agency has grown to be one of the largest agencies in Michigan and, with recent acquisitions, expanded into Florida and California.

8

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — continued.

Program Business

The program business segment is engaged primarily in developing and managing alternative market risk management programs for defined client groups and their members. This includes providing services, such as reinsurance brokering, risk management consulting, claims handling, and administrative services, along with various types of property and casualty insurance coverage, including workers’ compensation, general liability and commercial multiple peril. Insurance coverage is primarily provided to associations or similar groups of members, commonly referred to as programs. A program is a set of coverages and services tailored to meet the specific requirements of a group of clients.

The following table sets forth the segment results (in thousands):

		Three Months Ended March 31,
		2000			1999
Revenues:
	Net earned premiums	$	33,268		$	26,159
	Management fees		6,137			4,952
	Investment income		2,787			2,709
	Program business segment		42,192			33,820
	Agency operations		4,275			4,357
	Intersegment revenue		(230	)		(261	)
	Consolidated revenue	$	46,237		$	37,916
Pre-tax income (loss):
	Program business	$	533		$	(2,659	)
	Agency operations		1,116			1,227
	Reconciling items		(1,788	)		(1,361	)
	Consolidated pre-tax loss	$	(139	)	$	(2,793	)

The pre-tax income reconciling items represent other expenses relating to the holding company, amortization and interest expense, which are not allocated among the segments.

9

MANAGEMENT REPRESENTATION

In the opinion of management, the financial statements reflect all adjustments of a normal recurring nature necessary for a fair presentation of the interim periods. Preparation of financial statements under GAAP requires management to make estimates. Actual results could differ from those estimates. Interim results are not necessarily indicative of results expected for the entire year. These financial statements should be read in conjunction with the Company’s 1999 Form 10-K, as filed with the Securities and Exchange Commission.

Certain statements made by the Company in this document may constitute forward-looking statements. Actual results could differ materially from those projected in forward-looking statements. These forward-looking statements involve risk and uncertainties including, but not limited to the following: the frequency and severity of claims; uncertainties inherent in reserve estimates; catastrophic events; a change in the demand for, pricing of, or supply of reinsurance or insurance; increased competitive pressure; changing rates of inflation; and general economic conditions.

10

PART I — FINANCIAL INFORMATION

ITEM 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

For the Periods ended March 31, 2000 and 1999

Meadowbrook Insurance Group, Inc. (the “Company”) is a program-oriented risk management company specializing in alternative risk management solutions for agents, brokers, profession/trade associations, and insureds of all sizes. The Company owns insurance carriers, which are essential elements of the risk management process. Management defines its business segments as agency operations and program business operations based upon differences in products and services.

RESULTS OF OPERATIONS FOR THE PERIODS ENDED MARCH 31, 2000 AND 1999

Overview

2000 compared to 1999:

Results from operations, excluding the cumulative effect of an accounting change, increased $1.5 million, or 107.3% from a loss of $1.4 million in 1999 to net income of $105,000 in 2000.

Revenues for the quarter increased $8.3 million, or 22%, to $46.2 million in 2000 from $37.9 million in 1999. Revenues from program business increased $8.4 million, or 24.9%, to $42.2 million in 2000 from $33.8 million in 1999. Agency revenues decreased $82,000, or 1.9%, to $4.3 million in 2000 from $4.4 million in 1999.

Program Business

The following table sets forth the revenues and results from operations for program business (in thousands):

		Three Months Ended March 31,
		2000		1999
Revenue:
	Net earned premiums	$	33,268	$	26,159
	Management fees		6,137		4,952
	Investment income		2,787		2,709
	Total Revenue	$	42,192	$	33,820
Pre-tax income (loss):
	Program business	$	533	$	(2,659	)

11

MANAGEMENT’S DISCUSSION AND ANALYSIS — continued
For the Periods Ended March 31, 2000 and 1999

2000 compared to 1999:

Revenue from program business increased $8.4 million, or 24.9%, to $42.2 million in 2000 from $33.8 million in 1999. This increase reflects 27.2% growth in net earned premiums to $33.3 million in 2000 from $26.2 million in 1999. This increase reflects the 1999 acquisition which contributed $3.4 million. Excluding the impact of the 1999 acquisition, net earned premium increased 14%, or $3.7 million, reflecting growth in existing business. Management fees grew $1.1 million, or 22%, to $6.1 million from $5.0 million. This increase reflects the 1999 acquisition. Excluding the 1999 acquisition, management fees would be slightly down reflecting a decrease in fees for claims services. The remaining increase reflects an increase in investment income of $78,000, or 3%, from $2.7 million in 1999 to $2.8 million in 2000.

Program business in 2000 generated a pre-tax income of $533,000, which compares to a pre-tax loss of $2.6 million in 1999. The 1999 pre-tax loss in program business reflects the impact of the $4.7 million reserve strengthening charge. After excluding the 1999 reserve strengthening charge, the decrease in pre-tax program business reflects the increased pricing pressure that developed during the second half of 1999.

Agency Operations

The following table sets forth the revenues and results from operations for agency operations (in thousands):

	Three Months Ended March 31,
	2000		1999
Net commission	$	4,275	$	4,357
Pre-tax income	$	1,116	$	1,227

2000 compared to 1999:

Agency commissions decreased $82,000, or 1.9%, to $4.3 million in 2000 from $4.4 million in 1999. Agency operations generated pre-tax income of $1.1 million in 2000 compared to $1.2 million in 1999. This decrease primarily reflects a decrease in contingent commissions for 2000.

12

MANAGEMENT’S DISCUSSION AND ANALYSIS — continued
For the Periods Ended March 31, 2000 and 1999

Other Items

Interest Expense

Interest expense of $1,240,000 and $840,000 was recorded for the three months ended March 31, 2000 and 1999, respectively. This interest is related to utilization of the Company’s Line of Credit. The increase in interest expense is a result of both a higher average daily loan balance and higher average interest rates during 2000 as compared to 1999. The average daily loan balances during 2000 and 1999 were $55.7 million and $38.2 million, respectively. The interest rate increased from 7.5% at March 31, 1999 to 8.57% at March 31, 2000. The outstanding balance on this line was $55.8 million at March 31, 2000, as compared to $55.6 million at December 31, 1999.

Amortization Expense

Amortization expense of $480,000 and $345,000 was recorded for the three months ended March 31, 2000 and 1999, respectively. This increase in amortization is related to the goodwill recorded on the 1999 acquisition.

Taxes

The provision for income taxes was a $244,000 benefit for the three months ended March 31, 2000, and a $1.4 million provision for the same period in 1999, representing effective tax rates of 176% and 49%, respectively. Historically, the Company’s tax rates vary from the 34% corporate rate due to its heavily tax-exempt investment portfolio. Tax exempt securities at March 31, 2000 represented 50.5% of the portfolio, down from 53.2% at year-end, and down from 70.2% at March 31, 1999. The Company is shifting its portfolio to taxable securities, by reinvesting cash from operations and maturing securities and is completing an analysis of additional sales and purchases to re-balance the debt security portfolio aimed at maximizing after-tax investment yields and minimizing current outflow related to taxes.

Liquidity and Capital Resources

The principal sources of funds for the Company are insurance premiums, investment income, proceeds from the maturity and sale of invested assets, risk management fees and agency commissions. Funds are primarily used for the payment of claims, commissions, salaries and employee benefits, and other operating expenses. In addition, the Company has a high volume of intercompany transactions due to the payment of management fees by the insurance subsidiaries to the risk management subsidiaries, which are subject to regulatory approval by state insurance departments.

Cash flow provided by operations for the three months ended March 31, 2000 and 1999 was $7.1 million and $12.6 million, respectively. At March 31, 2000, the Company held $25.6 million in cash and cash equivalents.

The Company has an unsecured Line of Credit totaling $60.0 million, of which $55.8 million was outstanding at March 31, 2000 and $55.6 million was outstanding at December 31, 1999. The Line

13

MANAGEMENTS’S DISCUSSION AND ANALYSIS — continued
For the Periods Ended March 31, 2000 and 1999

of Credit expires on August 1, 2002. The Company drew on this Line of Credit during 1999 primarily to meet acquisition and cash flow needs.

One of the Company’s principal corporate objectives is to operate at appropriate leverage ratios. The Company plans to reduce its reliance on bank debt in 2000 from currently identified sources of capital.

14

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On June 26, 1995, two shareholders and an officer of a former agent (the “Primary Plaintiffs’) of Star, and a former spouse of one shareholder and an employee of the former agent (the “Individual Plaintiffs”) initiated legal proceedings against, among others, Star and Meadowbrook in the District Court for Washoe County, Reno, Nevada. All of the plaintiffs requested injunctive relief, compensatory damages, punitive and exemplary damages, and attorney’s fees in an unspecified amount. The Nevada Insurance Department revoked the license of one of the Primary Plaintiffs and one of the Individual Plaintiffs and denied further licensing of the other Primary Plaintiffs.

The Company vigorously defended itself and filed counter-claims against the Primary and Individual Plaintiffs. On April 1, 1998, the Court issued an Order dismissing all claims of the Primary Plaintiffs with prejudice.

On January 12, 1999, the remaining claims of the Individual Plaintiffs and the counterclaims of Meadowbrook and Star against the Primary and Individual Plaintiffs were tried. On February 2, 1999, the jury returned a verdict in favor of Meadowbrook and Star against the Primary Plaintiffs and Individual Plaintiffs. In addition, the jury found against the Individual Plaintiffs and in favor of Meadowbrook and Star on their remaining claims. On April 21, 1999, the Court found in favor of Meadowbrook and Star and against the Primary and Individual Plaintiffs on all outstanding claims for equitable relief. It is not expected that the outcome of this litigation will have a material impact on the financial condition of the Company.

A Final Judgment has been entered with the Court, which is subject to an appeal.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8K

(A)	The following documents are filed as part of this Report:
Exhibit No.		Description
11		Statement recomputation of per share earnings
27		Financial Data Schedule
(B)	Reports on Form 8-K
None

15

SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

Meadowbrook Insurance Group, Inc.
By:	/s/ William S. Lohmeyer
	Sr. Vice President and Chief Financial Officer

Dated: May 15, 2000

16

Exhibit Index

Exhibit No.	Description
11	Meadowbrook Insurance Group, Inc. and Subsidiaries Computation of Per Share Earnings
27	Financial Data Schedule